Yen carry trade volatility a reminder that trusted technology and partnerships matter
Key Takeaways
- Nikkei crash and unwinding carry trade a reminder of market volatility
- Market infrastructure stood up well to the upheaval
- Trusted tech partners can provide the expertise and resources
In early August 2024, the Japanese markets experienced a major crash. On 05 August the Nikkei index experienced its biggest single-day fall since Black Monday in 1987. The impact of the crash quickly spread, and major American and European markets experienced similar downturns. However, most markets experienced a relatively quick recovery in the following weeks. This episode shows how quickly volatility can occur and spread in today’s interconnected world, but it also demonstrates how resilient infrastructure can help markets ride out such sudden storms.
There were two main triggers to the crash. First was the decision by the Bank of Japan (BoJ) to raise interest rates by 15 base points. This was an unexpectedly hawkish move by the Bank, which had already raised rates for the first time in 17 years in March, ending a long period of negative interest rates. This was in response to recent inflationary pressures in the Japanese economy, which has previously been experiencing a long period of deflation. This was quickly followed by a disappointing US monthly jobs report, raising expectations of a cut to US interest rates by the Federal Reserve. The combination of these two events promoted an unwinding of so-called ‘Yen carry trade’ positions, prompting turmoil in the markets.
What is the Yen carry trade?
A Yen carry trade is an investment strategy where investors borrow money in Japanese Yen, which typically has low interest rates, and then convert it into a currency with higher interest rates to invest in higher-yielding assets. The goal is to profit from the difference in interest rates between the two currencies.
The Yen carry trade was an attractive strategy because Japan has maintained very low interest rates for an extended period. This low cost of borrowing allowed investors to leverage their positions significantly. By borrowing large amounts of Yen and investing in higher-yielding assets, investors could achieve significant gains. The strategy had only become more attractive in recent years as other developed economies raised interest rates, resulting in a more substantial differential. In addition, the long period of stable Yen exchange rates reduced the risk of significant currency fluctuations that could erode profits.
The big unwind
The combination of increasing Japanese interest rates and fears of a weakening US economy reduced the attractiveness of borrowing in Yen to invest in dollar-denominated assets. This led to a rapid unwinding of carry trade positions as investors rushed to repay their Yen-denominated loans. The sudden demand for Yen caused its value to spike.
The strengthening Yen triggered margin calls for investors who had borrowed Yen to invest in higher-yielding assets. To meet these margin calls, investors had to sell off their investments, including stocks, leading to a sharp decline in stock prices.
The unwinding of Yen carry trades didn’t just affect Japanese markets. Since many investors used the borrowed Yen to invest in global assets, the sell-off spread to other markets, amplifying the downturn. The rapid changes in the Yen’s value and the subsequent sell-off in global markets increased overall market volatility. This heightened uncertainty further eroded investor confidence, contributing to the market crash.
In response to the crash, the BoJ committed to maintaining interest rates at their current level while markets remained unstable. This move aimed to stabilize the financial markets and restore investor confidence, contributing to the relatively rapid recovery in market prices in the following weeks.
The major Japanese exchanges avoided making high-profile interventions during the crash, although some allowed price limits were extended to avoid trading suspensions.
Resilient infrastructure and trusted partners
In general, the wider market infrastructure, including third-party platforms, stood up well to the unexpected volatility. For example, ION recorded three days of record order counts across our Fidessa Japanese Trading Platform in early August without any major incidents or service interruptions.
The market crash and rapid recovery illustrate how sudden and unexpected episodes of volatility can occur. As global markets become more and more complex and interconnected, such events become more likely. Complex, cross-border strategies like the Yen carry mean that a policy change or event in one country can have widespread impacts, triggering volatility in markets across the world.
However, the crash also illustrates the resilience of modern market infrastructure. Exchanges and wider market infrastructure (such as software platforms) were able to cope with both surging trading volumes and large price movements. As such episodes of volatility become more common, having the resilience to navigate them becomes critical. All capital markets firms, whether they operate globally or within a single country, must be prepared for volatility. Working with trusted partners can provide the expertise and resources can help firms navigate this uncertain landscape.
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If you’d like to find out more about how ION can help you manage global volatility, contact us today.